Stagflation looms in UK as economic growth grinds to a halt


The UK economic recovery stalled in February and March as inflation surged to its highest level in 30 years, in the worst combination of surging prices and zero growth since the 1970s.

The prospect of prolonged stagflation is at odds with Prime Minister Boris Johnson’s claims of a strong economic bounceback from the coronavirus pandemic in the latest figures.

Gross domestic product declined 0.1 per cent between February and March, data published by the Office for National Statistics showed on Thursday, below the no change forecast by economists polled by Reuters.

It follows zero growth in the previous month, a downward revision from an initial reading of 0.1 per cent expansion.

This comes as consumer prices rose at an annual rate of 7 per cent in March, the fastest increase since 1992, according to data released last month.

James Smith, research director at the Resolution Foundation think-tank, said: “The economy already appears to be losing momentum as the cost of living crisis intensifies and the risk of stagflation looms.”

Over the first quarter as a whole, the UK economy expanded 0.8 per cent over the previous three months, boosted by stronger growth in January. However, that was below analysts’ expectations of 1 per cent and down from the 1.3 per cent increase in the previous quarter.

Paul Dales, chief UK economist at consultancy Capital Economics, said some of March’s weaknesses in consumer-facing services, such as retail sales and the hospitality sector, might be because of the cost of living crisis forcing households to cut their spending on non-essential items. “This is particularly ominous when our forecasts imply that the surge in inflation will reduce households’ real incomes the most in the next six months,” he added.

Chancellor Rishi Sunak boasted that UK quarterly growth was faster than in the US, Germany and Italy.

However, the difference largely reflects the timing of Omicron coronavirus infections and the fact that British households were temporarily shielded from the surge in energy prices in the first quarter by Ofgem’s default tariff cap, which is reset only in April and October. In contrast, consumers in most other countries were hit almost immediately by higher prices.

Even with these differences, the UK economy was 0.7 per cent above its level in the last quarter of 2019 before the pandemic, which was marginally stronger than the eurozone’s 0.4 per cent but below France and the US.

Line chart of GDP index rebased (Q4 2019=100) showing the UK economic recovery from the pandemic is on a par with the eurozone

Speaking at the start of a cabinet meeting in Stoke-on-Trent, Johnson said the economic data was encouraging.

“The most extraordinary thing about the way the country came back from the pandemic was the strength of the employment position . . . that is the single most important thing we need to focus on: a strong jobs-led recovery,” he said. “I am encouraged by some of the growth figures I just saw this morning . . . jobs, jobs, jobs is the answer.”

Speaking earlier on LBC, the prime minister said growth “will return very strongly in the next couple of years”.

This contrasts with warnings from many economists of the growing risks of a recession, defined as two quarters of economic contraction.

The Bank of England warned of a recession last week as inflation is set to rise to a 40-year high of about 10 per cent in the autumn, in the wake of ever-increasing energy costs. The central bank forecast that the economy would alternate between near stagnation and contraction over the next two years, with output barely changing by the first quarter of 2024.

“It is clear the UK faces a serious fight to avoid recession this year,” said Ed Monk, associate director at investment management company Fidelity International.

Samuel Tombs, economist at consultancy Pantheon Macroeconomics, said he expected GDP to contract 0.4 per cent in the second quarter as health spending declines and consumers tighten their belts.

The pound, a bellwether of the UK’s relative macroeconomic performance, dropped 0.4 per cent on Thursday morning and continues to trade near pandemic-era lows against the dollar.

Despite the weak economic outlook, markets expect the BoE to raise its main interest rate from 1 per cent to 2 per cent by the end of the year.

ONS data showed that the UK’s trade deficit for goods and services widened to a record 5.3 per cent of nominal GDP in the first quarter — the largest gap since records began in 1955 — as imports rose 9.3 per cent, largely reflecting higher energy prices, while exports fell 4.9 per cent. The fall in exports was broad-based with contractions in machinery, cars and fuels, as well as financial and business services.

The war in Ukraine also resulted in UK goods trade with Russia falling almost 70 per cent in March.

Business investment fell 0.5 per cent in the first quarter and was 9.1 per cent below its pre-pandemic level, as well as being 8 per cent below that of the first quarter of 2016 before the Brexit referendum, reflecting high business uncertainty. This is despite the government’s super-deduction policy, a two-year tax break on investment that has been in place since April 2021.

Line chart of Index, Q1 2016=100 showing UK business investment has yet to recover

Investment matters for productivity growth, which ultimately drives wage growth and standards of living.

Sandra Horsfield, economist at Investec, said: “Boosting productivity through higher investment will be a crucial ingredient in containing cost pressures for businesses in light of surging wage bills. So, a further shortfall in this regard is a concerning signal.”

A 15.1 per cent drop in car sales contributed to March’s fall in output. However, activity slipped 0.2 per cent across the entire services sector and output fell at the same rate in manufacturing.

The contraction in March’s GDP would have been sharper if it was not for an unusually strong 1.7 per cent growth in construction, which the ONS attributed to repair work after February storms.

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